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Copyright by Saad Siddique 2020 the Thesis Committee for Saad Siddique Certifies That This Is the Approved Version of the Following Thesis Copyright by Saad Siddique 2020 The Thesis Committee for Saad Siddique Certifies that this is the approved version of the following Thesis Exploring strategic motives behind cost and time overruns in oil and gas infrastructure projects APPROVED BY SUPERVISING COMMITTEE: Svetlana Ikonnikova, Supervisor Britt Freund Kasey Faust Exploring strategic motives behind cost and time overruns in oil and gas infrastructure projects by Saad Siddique Thesis Presented to the Faculty of the Graduate School of The University of Texas at Austin in Partial Fulfillment of the Requirements for the Degree of Master of Science in Energy and Earth Resources The University of Texas at Austin August 2020 Abstract Exploring strategic motives behind cost and time overruns in oil and gas infrastructure projects Saad Siddique, M.S. The University of Texas at Austin, 2020 Supervisor: Svetlana Ikonnikova Problems most frequently discussed in the regard of cost and time overruns in project management literature are planning failures, such as understated budgets, underrepresented technical complexity, and issues with public approval. Less frequent are discussions of changes in project scope and technical complexity related changes in market, industry, and policy environments. Most examples of impacts of market conditions on decision making prior to final investment decision (FID) are found, while little focus is found on how projects underway are impacted and dealt with. This thesis study will contribute to that latter strand of literature and explore how changes in project timeline and technical specifications can be interrelated to changes in market and policy parameters and therewith, may be justified from a project economics standpoint. To be specific, the study will focus the situation of significant drop in oil prices and natural gas prices and fast changing environmental regulations since 2014. On one hand, decreasing capital spending by oil and gas upstream companies led to decrease in supply. On the other hand, the prices of equipment are falling. Midstream companies may decide to increase the construction iv time of their projects to enjoy lower equipment costs, and to have the start of their project be associated with the return of higher oil and gas prices and therewith increased demand for newly- installed capacities which would warrant higher profits. This thesis performed decision tree analysis and net present value (NPV) calculation for a post-FID mid-construction pipeline infrastructure project to understand whether cost and time overruns may have potentially positive value from a theoretical and practical perspective. In particular, the study proposes how making decision changes to project timelines and specifications at that stage can alter the economic viability of the projects and give them a better chance at avoiding economic failure despite the overruns. This thesis will provide a decision- making method for project managers and contractors for situations where unexpected drastic changes in market conditions might affect the success for a mid-construction project. It will seek to provide information to potential investors and FID makers about the fate of similar projects. v Table of Contents List of Tables .......................................................................................................................x List of Illustrations ............................................................................................................. xi Chapter 1: Introduction ........................................................................................................1 1.1 BACKGROUND: COST AND TIME OVERRUNS ...........................................1 1.1.1 Cost and time overruns major problem in oil and gas ...........................1 1.1.2 Causes for overruns................................................................................1 1.2 CONTEXT ............................................................................................................3 1.2.1 Scope change .........................................................................................3 1.2.2 Market changes causing scope change ..................................................5 1.2.3 Oil and gas price turmoil........................................................................6 1.3 RELEVANCE .....................................................................................................12 1.3.1 Impact of falling prices on oil and gas industry ...................................12 Increase in costs ...................................................................................12 Increase in debt ....................................................................................12 Lower Revenues...................................................................................13 Impact on project Economics...............................................................14 Delaying or Cancelling Projects ..........................................................15 1.3.2 Examples of oil and gas projects with cost and time overruns due to price crashes .....................................................................................................16 Impact of demand and price uncertainty ..............................................16 Change in economics/profitability .......................................................18 Waiting for costs and prices to rebalance ............................................20 vi Making changes to scope and costs .....................................................20 After final investment decision ............................................................21 Taking advantage of low costs .............................................................23 1.4 RESEARCH GAP AND SCOPE .......................................................................25 Chapter 2: Literature review of response to impact of changing oil and gas economics on infrastructure projects ..................................................................................................27 2.1 RELATIONSHIP BETWEEN OIL PRICES AND COSTS IN THE OIL AND GAS INDUSTRY ..........................................................................27 2.1.1 Oil prices drive production and construction costs .....................27 2.1.2 Oil and gas prices influence cost efficiencies .............................28 2.1.3 Oil and gas prices volatility influencing contracts ......................29 2.2 LITERATURE ON DELAYING PROJECTS AND CHANGING SPECIFICATIONS .............................................................................................29 2.2.1 Delaying projects under uncertainty for more information .................29 2.2.2 Changing project specifications in response to changing project economics caused by market changes .......................................................................31 2.3 THEORETICAL ISSUES RELEVANT TO PROBLEM ..................................31 2.3.1 Stage financing.....................................................................................31 2.3.2 Project flexibility and its need under uncertainty ................................32 Project flexibility can be good .............................................................32 How to achieve flexibility in projects? ................................................33 Flexibility in investment decisions ......................................................35 2.3.3 Value of information ...................................................................35 2.3.4 Cost of delay ........................................................................................36 2.3.5 Attitude towards risk ............................................................................37 2.3.6 Trade-offs between costly delays and valuable information ...............38 vii 2.4 METHODOLOGIES ..........................................................................................39 2.4.1 Decision tree in decision theory ...........................................................39 2.4.2 Utility theory ........................................................................................39 2.4.3 Opportunity cost...................................................................................40 2.4.4 Real options view of NPV ...................................................................41 2.5 SUMMARY ........................................................................................................43 Chapter 3: Pipeline projects ...............................................................................................44 3.1 PIPELINES STAGES OF DEVELOPMENT AND INVESTMENT ................44 3.2 PIPELINE CAPACITY AS A FUNCTION OF ITS DIAMETER AND PRESSURE GRADIENT ........................................................................................................45 Chapter 4: Analytical Modeling: Post-FID Pipeline construction project under uncertainty47 4.1 DECISION TREE FOR PIPELINE PROJECT MANAGER ............................47 4.2 DECISION MAKING PROCESS USING DECISION TREE ..........................48 4.3 DECISION OPTIONS ........................................................................................49 4.4 ASSUMPTIONS .................................................................................................50 4.5 VALUE FUNCTION ..........................................................................................50 4.5.1 Value function (NPV) formulae for each outcome ..............................51 Notations
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